2 an introduction to cost terms and purposes - Pearson Learning ...

EXHIBIT 2-4
$160,000
Fixed-Cost Behavior
at Thomas Transport
Company
Total Fixed Costs
$120,000
$80,000
$40,000
Relevant
Range
in 2007
$0
120,000 240,000
Miles of Hauling
360,000
trucks that carry agricultural produce to market. Each truck has annual fixed rental costs of
$40,000. The maximum annual usage of each truck is 120,000 miles. In the current year
(2007), the predicted combined total hauling of the two trucks is 170,000 miles.
Exhibit 2-4 shows how annual fixed costs behave at different levels of miles of hauling.
Up to 120,000 miles, TTC can operate with one truck; from 120,001 to 240,000 miles, it operates
with two trucks; from 240,001 to 360,000 miles, it operates with three trucks. This pattern
will continue as TTC adds trucks to its fleet to provide more miles of hauling. Given the
predicted 170,000-mile usage for 2007, the range from 120,001 to 240,000 miles hauled is
the range in which TTC expects to operate, resulting in fixed rental costs of $80,000. Within
this relevant range, changes in miles hauled will not affect the annual fixed costs.
Fixed costs may change from one year to the next. For example, if the total rental fees
of the two refrigerated trucks is increased by $2,000 for 2008, the total level of fixed costs
will increase to $82,000 (all else remaining the same). If that increase occurs, total rental
costs will be fixed at this new level of $82,000 for 2008 for miles hauled in the 120,001
to 240,000 range.
The basic assumption of the relevant range also applies to variable costs. That is, outside
the relevant range, variable costs, such as direct materials, may not change proportionately
with changes in production volume. For example, above a certain volume, direct
material costs may increase at a lower rate because of price discounts on purchases greater
than a certain quantity.
Relationships of Types of Costs
We have introduced two major classifications of costs: direct/indirect and variable/fixed.
Costs may simultaneously be:
■ Direct and variable
■ Direct and fixed
■ Indirect and variable
■ Indirect and fixed
Exhibit 2-5 shows examples of costs in each of these four cost classifications for the BMW X5.
CHAPTER 2
34
4
Interpret unit costs
cautiously
. . . for many decisions,
managers should use total
costs, not unit costs
Total Costs and Unit Costs
The preceding section concentrated on the behavior patterns of total costs in relation to
activity or volume levels. We now consider unit costs.
Unit Costs
Generally, the decision maker should think in terms of total costs rather than unit costs.
In many decision contexts, however, calculating a unit cost is essential. Consider the
chairman of the social committee of a fraternity, who is trying to decide whether to hire
a musical group for an upcoming party. He estimates the cost of hiring the group to be
$1,000. This knowledge is helpful for the decision, but it is not enough.
ISBN: 0-536-53243-5
Cost Accounting: A Managerial Emphasis, Twelfth Edition, by Charles T. Horngren, Srikant M. Datar, and George Foster.
Copyright © 2006 by Pearson Education, Inc. Published by Prentice Hall.